Travelers Upgraded to Outperform

We are upgrading The Travelers Companies, Inc. (TRV - Analyst Report) to Outperform from Neutral on the back of solid third quarter performance. The third quarter earnings outperformed our expectations due to lower catastrophe losses, sturdy underwriting results and solid investment income. Top line also surpassed our expectations, driven by the augmentation in premiums earned and net investment income.

Travelers Business Insurance continued to deliver positive trend in net written premiums on the back of pricing gains and positive audit premiums. Though retentions were at a high level, new businesses somewhat remained lower. The company, however, remains comfortable with lower business volume as it believes higher pricing has generated better margins.

After a long gap of five quarters, Travelers enjoyed higher investment income. Net investment income in the quarter improved 4.6% year over year, largely attributable to better performance at non-fixed income portfolio. Given the weak interest rate environment, we expect slow improvement in the net investment income, though the effect is expected to be neutralized following the company’s efforts to improve its performance.

Travelers has always remained focused on returning more value to its shareholders. It paid $179 million in dividends in the third quarter. Its dividend yield is 2.66%, better than that of its nearest peers, Hartford Financial Services Group (HIG - Analyst Report) with a yield of 1.87% and W. R. Berkley Corp. (WRB - Analyst Report) with a yield of 0.93%. The company has also outperformed the sector average of 1.98%. In the third quarter, Travelers spent $350 million to buy back 5.4 million shares. The company also stated that it has excess capital owing to solid operating results, which it intends to deploy in returning to shareholders. As a result, it expects share buybacks in the fourth quarter to be more than the third quarter.

On the flip side, exposure to catastrophe events always remains a headwind for property & casualty insurers. Though the company incurred catastrophe loss in the third quarter, it primarily stemmed from increases in estimated losses associated with wind and hail storms in several regions of the United States that occurred in the second quarter.

Travelers has significant exposure to asbestos and environmental claims and related litigation as a result of high market shares of historical acquisitions. In the past, the company had to make reserve additions for its asbestos exposure. We are concerned that Travelers may continue to take extraordinary reserve additions for both asbestos and environmental exposure.

Travelers currently carries a Zacks # 2 Rank, implying a short-term Buy rating.